A:

The lower rates that are found on bonds, especially government-backed bonds, are often not seen as enough by investors. This is the main driving force behind investors not wanting to invest in bonds. Most investors are more attracted to the potential double-digit returns that the stock market can produce, which are not seen as often in the debt market.

Despite the perception, the bond market can be very profitable for investors, as investing in bonds is considerably safer than investments in the equities market. It is often not until after an investment in the stock market goes wrong that investors realize how risky stocks can be. The underlying concept of this idea is the willingness of an investor to take on risk to reap a potentially greater reward. This is one of the most basic tenets of the financial markets; the more risk you take on, the greater the compensation you need to receive. Investing in the stock market is considered to carry more risk than the bond market and, therefore, it generally provides greater returns for investors in the long run. (To learn more, read Determining Risk And The Risk Pyramid.)

It is the impact of these greater returns on a person's investments that affects the investment that person will choose. For example, imagine that you were able to invest in the bond market and earn 5% on your initial investment of $10,000 every year for 30 years. In this case, your investment would grow to $43,219. On the other hand, if you were to invest in the stock market, which provides a higher return of, say, 10%, that initial $10,000 would grow to $174,494 or just over four times as much (20% would get you $2.3 million).

The possibility of earning four times as much money certainly influences investors to place their money in the stock market. It is important to note, however, that a 10% return on stocks is not guaranteed and there is still a potential for loss. Nevertheless, it is the potential for huge gains over time that draws people away from the bond market to the stock market.

For more information, review Financial Concepts: The Risk/Return Tradeoff.

RELATED FAQS
  1. Do long-term bonds have a greater interest rate risk than short-term bonds?

    The answer to this question lies in the fixed income nature of bonds and debentures, often referred to together simply as ... Read Answer >>
  2. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
  3. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... Read Answer >>
  4. What are the risks of investing in a bond?

    The most well-known risk in the bond market is interest rate risk - the risk that bond prices will fall as interest rates ... Read Answer >>
Related Articles
  1. Investing

    The Advantages Of Bonds

    Bonds contribute an element of stability to almost any portfolio and offer a safe and conservative investment.
  2. Investing

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  3. Investing

    Bond Funds Boost Income, Reduce Risk

    These funds can provide stable returns for those who depend on their investment income.
  4. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  5. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  6. Retirement

    Should I Invest in Bonds After I Retire?

    Yes, retirees should invest in bonds, but remember that not all bonds are safe investments. Seek the help of a financial advisor.
  7. Investing

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  8. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  9. Investing

    What Bonds Are Saying About The Next Stock Plunge

    The relationship between bonds and stocks can reveal a lot about the future direction of the stock market.
  10. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
RELATED TERMS
  1. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  2. U.S. Savings Bonds

    A U.S. government savings bond that offers a fixed rate of interest ...
  3. Fixed-Rate Bond

    A bond that pays the same amount of interest for its entire duration. ...
  4. Bond Fund

    A fund invested primarily in bonds and other debt instruments. ...
  5. Index-Linked Bond

    A bond in which payment of income on the principal is related ...
  6. Bond Rating

    A grade given to bonds that indicates their credit quality. Private ...
Hot Definitions
  1. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  2. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  3. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  4. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  5. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
  6. Wash-Sale Rule

    An Internal Revenue Service (IRS) rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security ...
Trading Center